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Wednesday, August 17, 2011

Japan manufacturers' newest hurdle: A strong yen

A soaring yen over the past year is adding an extra burden to Japanese manufacturers who are already pushing hard to rebound from the March 11 disaster.

The yen has gained about 11% in value over the past 12 months, from roughly ~¥86/US$1 to now ~¥77/$1. (Two years ago it was north of ¥100.) For many companies that's a double-edged sword: a higher yen means higher prices, sales, and profits, though it's somewhat hollow as it's not really tied to end-demand. But it's a big problem for companies whose costs depend upon domestic purchases and procurements, or who have higher exposure to exports vs. imports. Every ¥1 rise in the 2010 dollar/yen rate erased ¥2B from Sony's operating profit, for example; Honda loses ¥15B for every ¥1/USD appreciation.

"The yen trading below 80 yen to the dollar is an extraordinary level," noted Shuichi Aoto, managing director at Mitsubishi Motors, quoted by the Asahi Shimbun. (According to the paper, the ¥76.29/USD on Aug. 1 was fractionally shy of a post-WWII record.) "We will be in an extremely difficult situation even if we consider steps to cope."

The strong yen "has ushered in a period of Japanese manufacturer exodus," according to Toyota senior managing officer Takahiko Ijichi, quoted by the Nikkei. Sony's outsourced production now accounts for 50% of TV production, vs. 20% a year ago. Hitachi is considering widening its overseas materials/components procurement from current 36% to 50% or more. Mitsubishi Heavy Industries is ramping up its first nondomestic gas turbine plant (in the US), hoping that a local supply operation will reduce exposure to foreign exchange rates. Carmakers Toyota and Honda are building new plants and revising their corporate structure to improve proportions of local procurement in North America.

In our industry, even Toshiba is ready to rethink its flagship NAND flash operations, after the strong yen has cut operating margins in half (20% to 10%) in just six months. "If the yen stays this strong, we will have to examine each business to see if it can really continue operating in Japan," said exec officer Makoto Kubo, quoted by the Nikkei. Ramping output of more 2Xnm chips this year will help reduce costs, but "if the yen's appreciation reaches very high levels, the impact will be too big to offset through improvements in production technologies."

(Tokyo Electron, meanwhile, reports export sales for its equipment (semiconductor, FPD, PV) as yen; some settlements are in dollars, but forward exchange contracts are made at the time of booking, so "the effect of exchange rates on profits is negligible," the company said reporting its most recent fiscal numbers.)

Panasonic, too, is dented by foreign currency swings -- every ¥1 rise vs. the dollar and euro trims operating profits by ¥3.8B and ¥1.7B, respectively, notes managing director Makoto Uenoyama, in an interview with the Nikkei. "Given Japan's higher tax rates and power-supply restrictions, maintaining domestic production is becoming increasingly difficult." To help mitigate its currency exposure, the company is increasing its emphasis on "forward exchange contracts" beyond the current 50/50 proportion, and will push more procurement and production out of the country. Plans include moving procurement functions from its Osaka HQ to Singapore, procuring more parts and materials from China and other Asian countries, and raising overseas procurement ratio from 53% to 60% in fiscal 2012. A new Li-ion battery plant in Suzhou will take parts from local manufacturers, supplying batteries to Chinese PC makers, and Panasonic will increase some white-good production in India and Brazil for those local consumers.

Another problem: Korean companies have fought against their nation's similarly weak won by cutting prices of products, something that further handcuffs their Japanese rivals. "To compete against our South Korean rivals on an equal footing, we have no choice but to shift production overseas," Uenoyama said. And that might mean a dramatic shift in strategy. "I don't think we can survive if we continue to focus on selling consumer products. We should shift our attention to environment/energy-related operations and offer a package of energy-saving products to businesses and consumers," he said.

Beyond individual corporate efforts to minimize exposure by outsourcing or rebalancing import/export levels, there's not a lot that can be done to check the yen's ascent. A sluggish US economy and recent credit rating drop, and the Fed's subsequent pledge to freeze interest rates at basically zero for the next two years, won't help. (Nor that the yen is one of the currencies investors generally view as a "safer" investment in times of economic turmoil.) Eventually the Bank of Japan might step in and expand asset purchases or lower interest rates itself, though such moves won't be popular internationally, especially since the US has more freedom with its interest-rate levers, notes the Nikkei. But don't be surprised if the yen keeps getting stronger, maybe even to ¥74/$1, warns Osamu Takashima, chief foreign exchange strategist at Citibank Japan Ltd., quoted by the Nikkei.